Thank you for standing by, and welcome to the Audinate Group Limited 1H20 Results Announcement Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your tele phone keypad. I'd now like to hand the conference over to Mr. Aidan Williams, Chief Executive Officer and Co-founder.
Hi. Good morning, everyone. My name is Aidan Williams, and I'm CEO and Co-founder at Audinate. Thank you for joining us on our results call today. As many of you would be aware, Audinate is a technology company that provides networking hardware and software solutions to manufacturers of professional audio and video equipment. Our technology, called Dante, distributes audio and video signals across standard computer networks, replacing the expensive and inflexible point-to-point cabling that has historically been used to connect AV equipment. Thousands of commercial audio video systems around the world, in shopping centers, railway stations, lecture theaters, hotels, houses of worship, TV and radio stations, convention centers, and many more other places, use Dante networking to deliver high-quality AV experiences using IT infrastructure.
If you turn to slide three of the presentation that we've published on the ASX site, you will find the financial and operational summary for the first half of FY20. Overall, Audinate continued to grow, with revenue in Australian dollars increasing by 14% to AUD 16.1 million. This is a solid result, but below historical U.S. dollar growth rates, largely due to the impact of U.S. tariffs and a general economic slowdown in China. Compared to the prior period, gross margin dollars increased 20% to AUD 12.5 million in Australian dollars due to revenue growth and a favorable shift in product mix towards higher margin software products. Gross margin percentage increased to 77.1% from 76.3%, due to an increasing proportion of higher margin software products. We expect that software sales will continue to become a larger proportion of our product mix over time.
Operating cash flow increased to AUD 2.9 million from AUD 0.6 million due to revenue growth. That's a pleasing result, as we have also begun investing in additional R&D headcount during the half. Operationally, the business continued to track well, with key metrics improving during the half. The total number of products on the market containing Dante technology grew by over 35% to 2,321 as at the 31st of December. This figure represents the size of the Dante-enabled product catalog available to designers of AV systems. In addition, the recent European trade show, Integrated Systems Europe, that took place mid-February, saw a record number of 147 new Dante products launch, taking the total current number of Dante products on the market to over 2,500. This half also saw an increase in the number of software-based Dante unit shifts, up 11.7% to 98,000.
We expect this to further improve on the back of strong manufacturer interest in our new software-based Dante products. The number of manufacturers adopting Dante also continues to grow, with the number of manufacturers shipping at least one Dante product increasing 28% to 292 as at the 31st of December. The business experienced headwinds during the half, primarily due to a combination of U.S. import tariffs and an economic slowdown in China. Our China sales team is reporting a general slowdown in the wider professional AV industry in China. This has been reflected in a 33% decline in sales of Dante components in Asia, largely seen as reductions in orders for our lower priced Ultimo chips. Please note that these effects took place before the current outbreak of the novel coronavirus.
Revenue expected in the first half from new software products, Dante Embedded Platform and Dante Application Library, has also been delayed due to manufacturers delaying the launch of their products using these new Dante software products. We expect to see revenue from these software products in the second half, since those products are near complete and being publicly demonstrated by those manufacturers. The new Dante AV product design suite was also delayed by a quarter due to manufacturer requests for changes. This delayed designing revenue associated with the Dante AV product design suite. However, we expect the changes that we have made to facilitate and accelerate future design wins. Additionally, the U.S. tariff situation remains dynamic.
Historically, Audinate has used contract manufacturing based in mainland China, and therefore, the adapter and Brooklyn products have been subject to U.S. import tariffs. During this half, U.S. tariffs were threatened, first reduced, and then reduced. This has likely affected growth in the sale of the products based on Brooklyn and Virtual. Going forward, we expect to eliminate the effect of U.S. tariffs by manufacturing goods bound for the U.S.A. in Malaysia. I'll have more to say on this topic later in the presentation when we get to the outlook section. Slide four summarizes several key metrics for the business indicating continued interest and adoption of Dante by manufacturers and end users. As previously mentioned, the total number of Dante products on the market now exceeds 2,500, with a record number of 147 new products announced at the large mid-February trade show in Europe.
Major equipment manufacturers, who are existing customers of Dante, continue to deepen their usage of Dante in their product portfolios, with new Dante products from major brands like Yamaha, Sennheiser, Extron, and Kramer being announced. Metrics associated with marketing activity continue to track strongly, with in excess of 80,000 AV industry professionals having completed at least one Dante certification course. Website traffic, new accounts, and marketing contacts continue to grow, and sales and download of end-user software products like Dante Virtual Soundcard and Dante Controller continue to grow strongly. On the competitive front, the chart on slide five shows the network effects associated with the interoperable ecosystem of Dante products continuing to grow. This is the last update that will count CobraNet products, with RH Consulting not considering it to be a relevant technology in the industry going forward.
The takeaway from this slide is that Dante continues to extend its lead with seven times more products than the next nearest competitor, or even more if CobraNet is disregarded. To support long-term growth in the business, Audinate has several medium-term strategies and goals as shown on slide six. In this half, notable activities shown on the right against our medium-term goals and strategies shown on the left include beginning the growth of our engineering and R&D functions. We've added 13 new positions in engineering, product management, and technology development. Bringing Malaysian contract manufacturing online to avoid U.S. tariffs. Rolling out new product development processes with Scaled Agile Framework to manage engineering and product development, and new HR information system and travel management platforms. New audio and video feature developments, notably tweaks to the Dante AV product design suite in response to early customer feedback.
Importantly, closing seven design wins for new products in the form of Dante AV and new software-based Dante products. In the near term, the revenue and operational priorities for the business are summarized on slide seven. On the operational side, we will continue to deliver our existing mature hardware products, taking advantage of Malaysian manufacturing to avoid U.S. tariffs. On the execution side, completing delivery of new products will unlock new design wins and repeat orders. On the sales side, growing the pipeline of customers for new Dante video and software products is a priority. We aim to close a total of at least 20 design wins for new Dante software and video products in this financial year. On the marketing side, we have added training resources in Europe, China, and Latin America, which will drive further interest in Dante amongst AV professionals around the world.
With that, I'll turn over to Rob Goss, Audinate CFO, to present financial results and business metrics in more detail.
Thanks, Aidan. Good morning, everyone. Over the next few minutes, I will be explaining the first half 2020 financial results that were lodged with the ASX earlier today, and are summarized in the accompanying investor presentation. The particular information I'm going to talk to is set out in the investor deck on slides nine to 13, and all amounts quoted will be in AUD. Aidan previously talked to some high-level factors impacting revenue during the first half. From the product perspective, the increase in revenue from chips, cards, and modules is attributable to continued growth in our Brooklyn and Broadway products, whilst growth in software revenue is attributable to royalty, Dante Domain Manager, and sales of Dante Virtual Soundcard and Dante Via. Overall operating expenses have increased from AUD 8.7 million in the prior period to AUD 9.6 million for first half 2020.
As we outlined at the time of the capital raise last year, and at the time of our FY 2019 results, we see enormous opportunities in the near term and aim to double the size of the engineering team over the next few years and ensure we have the business infrastructure in place to support our growth agenda. Overall, headcount has grown to 105 from 81 at the corresponding time last year. Since 31 December 2019, we've added a further nine people, so the total headcount is now 114. In terms of the engineering team, we've gone from 40 people at 30 June 2019 to 50 people now, and continue to feel that ourselves well-placed to meet this growth. Employee expenses have been impacted by some one-off impacts from the departure of our former CEO, Lee Ellison, who finished at Audinate at the end of last year.
At the AGM, the shareholders approved the acceleration of vesting conditions for Lee's performance rights, which resulted in an additional non-cash charge of approximately AUD 300,000 during the period. There were a further AUD 200,000 related to U.S. employer taxes paid on equity grants to Lee during the period. We have also reclassified director fees into employee expenses from other operating expenses. The detail of this is set out on page 12 of the financial statements. Marketing expenses are seasonally lower in the first half, given that the main trade shows take place in the second half of the financial year. Accordingly, marketing expenses are expected to increase in the second half of the year again in 2020. We applied the lease and lease accounting standard with effect from 3rd of July 2019. Comparatives from that require to be restated.
The impact can be found on the balance sheet as a right-of-use asset with a corresponding lease liability. In terms of P&L, this means that premises costs are now accounted for depreciation and amortization, which amounted to approximately AUD 300,000 in the current period. If the prior period was adjusted to be on a like-for-like basis then the comparable for last period would have been approximately AUD 1.9 million. At an income level, the increased depreciation and amortization in the current period flow through and drive the movement between first half 2019 and first half 2020. Operating cash flow increased from AUD 600,000 in first half 2019 to AUD 2.9 million in first half 2020 as the benefit of additional gross margin flows from retained. In terms of cash flows, there are a couple of one-off items to call out in investing activity.
There were about AUD 500,000 of payments that are put out as a new business asset and a further AUD 400,000 for rental bonds for the same assets. Within financing activities, AUD 4 million of proceeds from the completion of share purchase plan came in at the beginning of July. There is also an anomalous outcome within financing activities which should be called out. In the U.S., Audinate is required to withhold employee taxes from the exercise of equity grants. Employees selling shares from the exercise of options or performance rights authorize our share registry to sell them on their behalf. Proceeds are remitted through our parent company in the U.S., who withhold the applicable employee taxes and remit the remaining amounts to the employee.
On 2 November 2019, we received approximately AUD 3 million from the private shares of our former CEO, which were remitted to him in early January. We do not consider this to be Audinate's cash from a practical point, it does meet the definition of cash under the accounting standard and, in effect, is a cash flow statement from the balance sheet of Audinate. Further detail is contained in the financial statements in note 10. The balance sheet remains strong, and the company continues to have no debts. I will now hand back to Aidan to discuss new products and outlook.
Thanks, Rob. In the next few slides, I want to provide a brief update on the new software and video products we launched during the last year. A major milestone last year was the addition of video support to the Dante networking solution. Slide 15 shows a couple of articles reflecting industry reaction to the launch of Dante AV. We have at this point four design wins for Dante AV, and even though there are no shipping Dante video products from manufacturers, the bar charts shown on this slide come from a survey carried out by Commercial Integrator Magazine, indicating that AV integrators have a high degree of confidence that Dante AV will meet their needs. We believe that this confidence comes from the positive experience integrators have with Dante audio products, and that all bodes well for the adoption of Dante AV products when they become available.
The article linked at the top right points towards the potential for Dante AV to create an interoperable ecosystem for networked video products like the one already available for Dante audio products. If we succeed, the article suggests that this will be a game changer for the industry. Dante AV has generated strong interest with a pipeline of design win opportunities. To date, we have closed four design wins using the products shown on the left-hand side of slide 16. These include Yamaha and Bolin, a manufacturer of pan-tilt-zoom video cameras. A prototype Dante AV camera was demonstrated in conjunction with Bolin at the recent ISE trade show in Amsterdam.
The delivery of the Dante AV product design suite has been delayed by a quarter due to customer requested modifications. With these modifications in place, we expect that the Dante AV product design suite will meet the needs of a wider variety of manufacturers who wish to get to market quickly with a networked video product based on this reference design. On the software side, slide 17 highlights progress with new Dante software products. QSC, the initial customer for the Dante Embedded Platform software product, has delayed their rollout of Software Dante, with launch now expected in March this year. We anticipate pent-up demand from this half to be delivered during the next half as that product comes online. Zoom has incorporated the Dante Application Library into their Zoom Rooms software application, and it has been quietly rolled out in a beta program.
The screenshot on the bottom right shows an iPad sitting in the Zoom Rooms software to connect to a Dante microphone. Finally, in a significant announcement at ISE, Shure launched a Shure software digital signal processor for conference room applications. In the past, Shure has delivered signal processing functionality in a hardware form, as shown by the black box in the center of the slide. With Dante Application Library, that same functionality can now be delivered as a Windows software application without the need to install any additional hardware. This product launch from a major brand has done a lot to validate the thesis that the AV industry is undergoing a hardware to software transition enabled by Dante networking technology.
In the near term, U.S. tariffs and associated changes in the Chinese economy due to supply chain restructuring are expected to continue, along with the uncertain impact associated with the recent outbreak of the novel coronavirus. I'm on slide 19 now, looking at the outlook. Despite these temporary headwinds, the company expects to deliver further revenue growth in the second half of FY 2020, although it is likely that the full-year result will be below the historical range of growth for our business. As described earlier in the presentation, delivering operationally on the manufacturing of existing products and achieving design wins on new software and Dante video products will continue to drive repeat revenues for the business.
Beyond FY20, business metrics and leading indicators such as the continued interest in Dante-enabled products, continued strong interest in Dante training amongst AV professionals, and the healthy sales pipeline for new products like Dante AV and software in Dante implementations provide confidence that the company is well-positioned to deliver attractive long-term growth for shareholders. In order to capitalize on the digital transformation of the AV industry, Audinate will continue to execute on its medium-term priorities to grow our product development capacity, to put in place the necessary business infrastructure and systems to scale, to deliver the next generation of Dante audio and video software products, all with the aim of substantially addressing the addressable market for the business, which we estimate to exceed AUD 1 billion. With that, I think we can move to a time of question and answer.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you are on a speakerphone, please pick up the handset to ask your question. Please note there is a limit of two questions per participant. Your first question comes from Danny Younis from Shaw and Partners. Please go ahead.
Hi, Aidan. Hi, Rob. My first question is around the second half outlook. Given your first half revenue growth was 14% and you've guided the second half below historical averages, let's say 26%, so that's occurring 15%-25% growth, which is a pretty large range, and I understand the uncertainty. Could you maybe give us a little bit more detail in terms of has there been a pronounced downtrend, say, from January to February from coronavirus on top of the tariffs last year and what that means in terms of demand and timelines?
Yeah. I think where we are at this point in time is reduction in demand is really related to the domestic Chinese economy, as we've indicated in the presentation. We have, at this stage, not seen any effect from the coronavirus, but I think it's certainly out there as a potential impact. January, I think, has been strong for us. In the conversations we've had with our top 20 customers, we noted sort of general indication globally that we're seeing an additional downturn, at least at the point at which we had those conversations, which was around December last year. There is just some uncertainty associated with the impact of the coronavirus and its effect on things like supply chain, which is at this point an unknown.
I think we have no reason to suspect that outside the domestic China market there are any sort of major headwinds at this point. There is just some potential uncertainty associated with the impact of the coronavirus, and like many companies, that's beyond our control.
My second question is around your gross margins. 77% is the strongest, I think, since 2016 for you guys. Well done on that front. I understand it's the mix shift from CCM into software. My understanding is over the last three to four years, this is the first time you've called out Via and DVS as being particularly strong. What's really driving that, and can you hold those gross margins at that level, 77%, given software is further increasing going forward?
Yeah. Hi, Danny. It's Rob. I'll take the first one. What we've called sort of retail sales or consumer software in the form of Dante Virtual Soundcard and Dante Via, it's been pretty steady over quite a period of time. In terms of that growth in software, it was really attributed to the three products in relatively similar dollar amounts. We've called it out for that reason. That is about 20% revenue growth, and they're the products which have been around for three or four years. We think that has been a real good sort of bellwether for the continued interest in Dante technology and the proliferation of that technology.
In terms of the second part of your question around the gross margin performance going forward, we do see in the medium term that we continue to shift to software and therefore an increased gross margin over time. In the near term, it will move around a little bit depending upon the proportion of chips to cards and modules revenue that we take, but that picks up in the second half and not the almost slight decrease in the near term.
Okay. Thanks, Aidan. Thanks, Rob.
Thank you. Your next question comes from Dan Coughlan from Credit Suisse. Please go ahead.
Oh, hi. Good morning. Quinn here, actually. Maybe first question on the cost investment that's occurring in the business and how to think about that investment going forward. Given some of the, I guess, macro headwinds on the business and slowing top line from that kind of historic range, is there a thinking to maybe moderate some of the cost investment expectations over the next year or two? I mean, you called out R&D doubling, kind of saying sales and marketing expenses will also grow up quite a bit. I mean, would you potentially slow that down to kind of protect the profit base, or is there a scenario here where profit could be kind of flat to maybe down for the next year or two?
I think generally speaking, Audinate is, we see ourselves as a technology business that's really establishing a platform in the AV industry, which is our Dante technology inside lots of amplifiers, microphones, speakers, that kind of stuff, throughout the industry. As we establish that platform, that gives us the capability to drive the transformation of the industry towards software-based delivery of AV solutions, as opposed to hardware-based solutions that they have at the moment. The key upside for Audinate is not so much in the chips and modules business that we have now, although it's a good business. We see the chips and modules business we have now as a land grab to establish a Dante networking solution as the foundation of a software platform for the industry.
For us, the key is to be able to continue to invest in the next phases of our strategy so that we can take advantage of the potential upside in that transformation in the medium term. Rob, did you want to add anything?
I think we've sort of previously flagged sort of account numbers of around about 130 or 130 plus as the target for the end of this year. I'll just reiterate what Aidan said. We're running with confidence to the medium term. We've set out a list of medium-term priorities, and we are in terms of continuing to execute them. There's a little bit of near-term uncertainty.
That's helpful. Then just secondly, you did call out that Asia, specifically China, is down by 1/3 in your revenue. Can you just remind us how much of group revenue is from Asia? If memory serves in August, in annual report, that was about 1/3 of the group.
Yeah. The specific sort of issue in China, we're probably seeing an effect of around about a half a million AUD with respect to China. That's a combination of loss of expected growth and downturn from the previous comparable period. The combination of those two is probably worth about AU$500,000 to Audinate. As a point of detail in the call out in the ASX release was sort of ex-Japan, which accounts for the-
Okay.
loss of Good enough.
Got you. No trouble. Thank you.
Thank you. Your next question comes from Tim from UBS. Please go ahead.
Yeah. Hi, guys. Just some questions from me if possible, please. Just firstly, in terms of the COVID impact or coronavirus impact, you mentioned potential supply issues. Could you give a sense, I mean, how much inventory do you have on board, and what's the kind of duration before it becomes an issue of not being able to get chips out? Second to that kind of how are your OEMs impacted by those same sort of issues?
Yeah. Our OEMs have similar sorts of issues to us to the extent that they manufacture hardware in China. Typically, we target, say, four turns per year. Generally speaking, we would look to have three months worth of inventory in the form of components and as well as manufacture in that kind of timeframe. The coronavirus impact at the moment has coincided with Chinese New Year. As a matter of sort of normal planning for the business, we expect manufacturing in China to basically go offline during Chinese New Year. What has happened is that has been extended out as a result of the actions that have been taken by the government in China. We've been monitoring this very closely. Our understanding for our own products is that we expect manufacturing to be coming back online, workers are coming back to the relevant factories.
At this point, we believe parts will be available, we're expecting to see manufacturing come back online over the next weeks. There is still some uncertainty associated with that. At this stage, we have no reason to believe that we're going to have trouble. There's still some uncertainty. It's also the case that shipments, freight is still being transported out of Hong Kong. We have the ability to deliver orders, and we're basically delivering all of the orders that we intend for our customers.
Got it. Just a second question around the penetration of products from the existing OEMs. Can you talk a little bit in terms of, that was a pretty big uplift in terms of new products that came on board. Are you seeing new products that are working their way down through the value range? So you're seeing more products come on at a cheaper rate. How are you looking at the quality of the new products coming on and how that assists your business in terms of going across the whole of the spectrum?
Yeah, I think there is a large number of products. I haven't personally gone and evaluated every 147 of each of those particular products. At the trade show, one of the things that was very noticeable was that there were several manufacturers that, when we turned up at their booth and said, asked them if they had any new Dante products, they kind of looked at us in a sort of mildly surprised fashion, then turned around and pointed to an entire wall of products. The interesting thing I think is that there's been several manufacturers that are launching whole portfolios of products. That for us, I think was a new thing that I see. In terms of the quality or driving the penetration lower, I think, we are seeing increased growth in Ultimo, but in particular in the Brooklyn product.
That is really starting to grow strongly now. They are a more, sort of Broadway, I mean Broadway, not Brooklyn. This is the eight to 16-channel chip product. These are sort of medium-scale Dante products. Driving that penetration into lower cost, more broadly available products, that is the purpose of Dante Embedded Platform for which we've seen very strong interest and there's a good pipeline of interested manufacturers for that.
Great. Thank you.
Thank you. Your next question comes from Chenny Wang from Morgan Stanley. Please go ahead.
Hey, guys. Thanks for taking my question. Maybe I'll just start on the first one with just diving a little bit deeper into the Asia revenues from being down 43%. Can you give us a sense of what really drove that between, I guess the tariff and economic slowdown? If you are able to give us a sense of, I guess, which one has the greater impact?
The tariff and the economic slowdown. I find them quite difficult to separate, because I think we were affected by the tariff in the sense that we do anticipate that there is some reduction in demand because of the tariff on our products that we manufacture in China. I think it's all tangled up because what has happened with the tariff is there has been supply chain restructuring in China. We've talked about the fact that we've established contract manufacturing in Malaysia. That has moved probably about a third of our manufacturing from mainland China to another country. The effect of that generally in the Chinese economy is probably that there's a general downturn in the Chinese economy.
Tariffs and the downturn in China I think are just strictly connected, or at least I'm not in a position to be really able to unpick those particular differences.
Thank you. The next question comes from Owen Humphries from Canaccord Genuity. Please go ahead.
G'day, guys. Thanks for taking my question. Just touching on the major trade shows, what % of products from your OEM partners are launched at trade shows? Is it the very high sort of %?
Yeah. Typically, it would be. There are two major trade shows, one in the middle of the year in June and one in February. There's a European one and an American one. They're in the commercial and pro AV space, so they're the largest trade shows for us, and likewise there's some European and an American broadcast-related trade show. The majority of products generally would be launched current financial year and would be weighted towards the second half of the financial year. That will be at one of the two major trade shows that Aidan just mentioned, or alternatively, there are a couple of extra shows in this part of the year. Generally speaking, if Q3 is a guide, we would expect a stronger increase in products in this half of the year.
Thank you. Your next question comes from Justin Pezzano from Blue Ocean Equities. Please go ahead.
Okay, guys, two questions from me. The first one is just around the Malaysian contract manufacturing side. Can you give us an idea of the impact on the supply costs, whether it's different to what you'd get in China?
Yeah. The Malaysian contract manufacturing is a factory that's been purchased by VTech, which is the same contract manufacturer who runs the factory in Maoming, China that we use. In transferring some of our manufacturing to Malaysia, the increase in cost has been negligible. There's essentially no difference to us with respect to cost, process, or indeed at this point, the operational side of it, because we can work through VTech and use both locations fairly transparently.
Thank you. Your next question comes from Claude Walker from Ethical Equities. Please go ahead.
Hi there. I don't know if you can answer this question, but I was wondering if you're able to sort of split up your technical staff numbers into, I guess, those working on hardware-based solutions and those already working on the next stage of the company development, which is the software-based solution. Be able to give a feel? Yeah.
Yeah, I think I can. Of the 93 staff members that we have at this point in time, probably somewhere between sort of five to seven of those are in the hardware kind of area. The majority of our engineers these days are software people, and they're working on products that are primarily software products, where we deliver software to equipment manufacturers by putting the software inside a printed circuit board module, like effectively a network card for a piece of AV equipment, or a chip where the software is pre-programmed into a chip so that the manufacturer can then put that on the board. We do anticipate most of the additional headcounts that's coming online will be software-oriented staff. That probably just reflects the general mix with our business anyway, where the technology itself is primarily in software form.
By the way, that 53 is the total headcount and our engineering team got 93.
Thank you. That does conclude our conference for today. Thank you for participating. You may disconnect.